BERNANKE: No New Policies; But Fed Has Lots Of Bullets Left, US Problems Are More Than Just Temporary

He basically says the growth outlook isn't great, and that the
Fed has more tools.

But he says nothing explicit.

Markets aren't moving much on this.

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The U.S. Economic Outlook

Good afternoon. I am delighted to be in the Twin Cities and would
like to thank the Economic Club of Minnesota for inviting me to
kick off its 2011-2012 speaker series. Today I will provide a
brief overview of the U.S. economic outlook and conclude with a
few thoughts on monetary policy and on the longer-term prospects
for our economy.

The Outlook for U.S. Economic Growth
In discussing the prospects for the economy and for policy in the
near term, it bears recalling briefly how we got here. The
financial crisis that gripped global markets in 2008 and 2009 was
more severe than any since the Great Depression. Economic
policymakers around the world saw the mounting risks of a global
financial meltdown in the fall of 2008 and understood the
extraordinarily dire economic consequences that such an event
could have. Governments and central banks consequently worked
forcefully and in close coordination to avert the looming
collapse. The actions to stabilize the financial system were
accompanied, both in the United States and abroad, by substantial
monetary and fiscal stimulus. Despite these strong and concerted
efforts, severe damage to the global economy could not be
avoided. The freezing of credit, the sharp drops in asset prices,
dysfunction in financial markets, and the resulting blows to
confidence sent global production and trade into free fall in
late 2008 and early 2009.

It has been almost exactly three years since the beginning of the
most intense phase of the financial crisis, in the late summer
and fall of 2008, and a bit more than two years since the
official beginning of the economic recovery, in June 2009, as
determined by the National Bureau of Economic Research's Business
Cycle Dating Committee. Where do we
stand? There have been some positive developments over the past
few years. In the financial sphere, our banking system and
financial markets are significantly stronger and more stable.
Credit availability has improved for many borrowers, though it
remains tight in categories--such as small business lending--in
which the balance sheets and income prospects of potential
borrowers remain impaired. Importantly, given the sources of the
crisis, structural reform is moving forward in the financial
sector, with ambitious domestic and international efforts under
way to enhance financial regulation and supervision, especially
for the largest and systemically most important financial
institutions.

Nevertheless, it is clear that the recovery from the crisis has
been much less robust than we had hoped. From recent
comprehensive revisions of government economic data, we have
learned that the recession was even deeper and the recovery
weaker than we had previously thought; indeed, aggregate output
in the United States still has not returned to the level that it
had attained before the crisis. Importantly, economic growth over
the past two years has, for the most part, been at rates
insufficient to achieve sustained reductions in the unemployment
rate, which has recently been fluctuating a bit above 9 percent.

The pattern of sluggish economic growth was particularly evident
in the first half of this year, with real gross domestic product
(GDP) estimated to have increased at an annual rate of less than
1 percent, on average, in the first and second quarters. Some of
this weakness can be attributed to temporary factors, including
the strains put on consumer and business budgets by the run-ups
earlier this year in the prices of oil and other commodities and
the effects of the disaster in Japan on global supply chains and
production. Accordingly, with commodity prices coming off their
highs and manufacturers' problems with supply chains well along
toward resolution, growth in the second half looks likely to pick
up. However, the incoming data suggest that other, more
persistent factors also have been holding back the recovery.
Consequently, as noted in its statement following the August
meeting, the Federal Open Market Committee (FOMC) now expects a
somewhat slower pace of recovery over coming quarters than it did
at the time of the June meeting, with greater downside risks to
the economic outlook.

One striking aspect of the recovery is the unusual weakness in
household spending. After contracting very sharply during the
recession, consumer spending expanded moderately through 2010,
only to decelerate in the first half of 2011. The temporary
factors I mentioned earlier--the rise in commodity prices, which
has hurt households' purchasing power, and the disruption in
manufacturing following the Japanese disaster, which reduced auto
availability and hence sales--are partial explanations for this
deceleration. But households are struggling with other important
headwinds as well, including the persistently high level of
unemployment, slow gains in wages for those who remain employed,
falling house prices, and debt burdens that remain high for many,
notwithstanding that households, in the aggregate, have been
saving more and borrowing less. Even taking into account the many
financial pressures they face, households seem exceptionally
cautious. Indeed,
readings on consumer confidence have fallen substantially in
recent months as people have become more pessimistic about both
economic conditions and their own financial prospects.

Compared with the household sector, the business sector generally
presents a more upbeat picture. Manufacturing production has
risen nearly 15 percent since its trough, driven importantly by
growth in exports. Indeed, the U.S. trade deficit has narrowed
substantially relative to where it was before the crisis,
reflecting in part the improved competitiveness of U.S. goods and
services. Business investment in equipment and software has also
continued to expand. Corporate balance sheets are healthy, and
although corporate bond markets have tightened somewhat of late,
companies with access to the bond markets have generally had
little difficulty obtaining credit on favorable terms. But
problems are evident in the business sector as well: Business
investment in nonresidential structures, such as office
buildings, factories, and shopping malls, has remained at a low
level, held back by elevated vacancy rates at existing properties
and difficulties, in some cases, in obtaining construction loans.
Also, some business surveys, including those conducted by the
Federal Reserve System, point to weaker conditions recently, with
businesses reporting slower growth in production, new orders, and
employment.

Why has this recovery been so slow and erratic? Historically,
recessions have tended to sow the seeds of their own recoveries
as reduced spending on investment, housing, and consumer durables
generates pent-up demand. As the business cycle bottoms out and
confidence returns, this pent-up demand, often augmented by the
effects of stimulative monetary and fiscal policies, is met
through increased production and hiring. Increased production in
turn boosts business revenues and increased hiring raises
household incomes--providing further impetus to business and
household spending. Improving income prospects and balance sheets
also make households and businesses more creditworthy, and
financial institutions become more willing to lend. Normally,
these developments create a virtuous circle of rising incomes and
profits, more-supportive financial and credit conditions, and
lower uncertainty, allowing the process of recovery to develop
momentum.

These restorative forces are at work today, and they will
continue to promote recovery over time. Unfortunately, the
recession, besides being extraordinarily severe as well as global
in scope, was also unusual in being associated with both a very
deep slump in the housing market and a historic financial crisis.
These two features of the downturn, individually and in
combination, have acted to slow the natural recovery process.

Notably, the housing sector has been a significant driver of
recovery from most recessions in the United States since World
War II, but this time--with an overhang of distressed and
foreclosed properties, tight credit conditions for builders and
potential homebuyers, and ongoing concerns by both potential
borrowers and lenders about continued house price declines--the
rate of new home construction has remained at less than one-third
of its pre-crisis peak. Depressed construction also has hurt
providers of a wide range of goods and services related to
housing and homebuilding, such as the household appliance and
home furnishing industries. Moreover, even as tight credit for
builders and potential homebuyers has been one of the factors
restraining the housing recovery, the weak housing market has in
turn adversely affected financial markets and the flow of credit.
For example, the sharp declines in house prices in some areas
have left many homeowners "underwater" on their mortgages,
creating financial hardship for households and, through their
effects on rates of mortgage delinquency and default, stress for
financial institutions as well.

As I noted, the financial crisis of 2008 and 2009 played a
central role in sparking the global recession. A great deal has
been and continues to be done to address the causes and effects
of the crisis, including extensive financial reforms. However,
although banking and financial conditions in the United States
have improved significantly since the depths of the crisis,
financial stress continues to be a significant drag on the
recovery, both here and abroad. This drag has become particularly
evident in recent months, as bouts of sharp volatility and risk
aversion in markets have reemerged in reaction to concerns about
European sovereign debts and related strains as well as
developments associated with the U.S. fiscal situation, including
last month's downgrade of the U.S. long-term credit rating by one
of the major ratings agencies and the recent controversy
surrounding the raising of the U.S. federal debt ceiling. It is
difficult to judge how much these events and the associated
financial volatility have affected economic activity thus far,
but there seems little doubt that they have hurt household and
business confidence, and that they pose ongoing risks to growth.

While the weakness of the housing sector and continued financial
volatility are two key reasons for the frustratingly slow pace of
the recovery, other factors also may restrain growth in coming
quarters. For example, state and local governments continue to
tighten their belts by cutting spending and reducing payrolls in
the face of ongoing budgetary pressures, and federal fiscal
stimulus is being withdrawn. There is ample room for debate about
the appropriate size and role for the government in the longer
term, but--in the absence of adequate demand from the private
sector--a substantial fiscal consolidation in the shorter term
could add to the headwinds facing economic growth and hiring.

The prospect of an increasing fiscal drag on the economy in the
face of an already sluggish recovery highlights one of the many
difficult tradeoffs currently faced by fiscal policymakers. As I
have emphasized on previous occasions, without significant policy
changes to address the increasing fiscal burdens that will be
associated with the aging of the population and the ongoing rise
in health-care costs, the finances of the federal government will
spiral out of control in coming decades, risking severe economic
and financial damage. But, while prompt and decisive action to
put the federal government's finances on a sustainable trajectory
is urgently needed, fiscal policymakers should not, as a
consequence, disregard the fragility of the economic recovery.
Fortunately, the two goals--achieving fiscal sustainability,
which is the result of responsible policies set in place for the
longer term, and avoiding creation of fiscal headwinds for the
recovery--are not incompatible. Acting now to put in place a
credible plan for reducing future deficits over the long term,
while being attentive to the implications of fiscal choices for
the recovery in the near term, can help serve both objectives.

The Outlook for Inflation
Let me turn now from the outlook for growth to the outlook for
inflation. Prices of many commodities, notably oil, increased
sharply earlier this year. Higher gasoline and food prices
translated directly into increased inflation for consumers, and
in some cases producers of other goods and services were able to
pass through their higher costs to their customers as well. In
addition, the global supply disruptions associated with the
disaster in Japan put upward pressure on motor vehicle prices. As
a result of these influences, inflation picked up significantly;
over the first half of this year, the price index for personal
consumption expenditures rose at an annual rate of about 3-1/2
percent, compared with an average of less than 1-1/2 percent over
the preceding two years.

However, inflation is expected to moderate in the coming quarters
as these transitory influences wane. In particular, the prices of
oil and many other commodities have either leveled off or have
come down from their highs. Meanwhile, the step-up in automobile
production should reduce pressure on car prices. Importantly, we
see little indication that the higher rate of inflation
experienced so far this year has become ingrained in the economy.
Longer-term inflation expectations have remained stable according
to the indicators we monitor, such as the measure of households'
longer-term expectations from the Thompson Reuters/University of
Michigan survey, the 10-year inflation projections of
professional forecasters, and the five-year-forward measure of
inflation compensation derived from yields of inflation-protected
Treasury securities. In addition to the stability of longer-term
inflation expectations, the substantial amount of resource slack
that exists in U.S. labor and product markets should continue to
have a moderating influence on inflationary pressures. Notably,
because of ongoing weakness in labor demand over the course of
the recovery, nominal wage increases have been roughly offset by
productivity gains, leaving the level of unit labor costs close
to where it had stood at the onset of the recession. Given the
large share of labor costs in the production costs of most firms,
subdued unit labor costs should be an important restraining
influence on inflation.

Monetary Policy
Although the FOMC expects a moderate recovery to continue and
indeed to strengthen over time, the Committee has responded to
recent developments--as I have already noted--by marking down its
outlook for economic growth over coming quarters. The Committee
also continues to anticipate that inflation will moderate over
time, to a rate at or below the 2 percent or a bit less that most
FOMC participants consider to be consistent with the Committee's
dual mandate to promote maximum employment and price stability.

Given this outlook, the Committee decided at its August meeting
to provide more specific forward guidance about its expectations
for the future path of the federal funds rate. In particular, the
statement following the meeting indicated that economic
conditions--including low rates of resource utilization and a
subdued outlook for inflation over the medium run--are likely to
warrant exceptionally low levels for the federal funds rate at
least through mid-2013. That is, in what the Committee judges to
be the most likely scenarios for resource utilization and
inflation in the medium term, the target for the federal funds
rate would be held at its current low level for at least two more
years.

In addition to refining our forward guidance, the Federal Reserve
has a range of tools that could be used to provide additional
monetary stimulus. We discussed the relative merits and costs of
such tools at our August meeting. My FOMC colleagues and I will
continue to consider those and other pertinent issues, including,
of course, economic and financial developments, at our meeting in
September and are prepared to employ these tools as appropriate
to promote a stronger economic recovery in a context of price
stability.

Conclusion
Let me conclude with just a few words on the longer-term
prospects for our economy. As monetary and fiscal policymakers
consider the appropriate policies to address the economy's
current weaknesses, it is important to acknowledge its enduring
strengths. Notwithstanding the trauma of the crisis and the
recession, the U.S. economy remains the largest in the world,
with a highly diverse mix of industries and a degree of
international competitiveness that, if anything, has improved in
recent years. Our economy retains its traditional advantages of a
strong market orientation, a robust entrepreneurial culture, and
flexible capital and labor markets. And our country remains a
technological leader, with many of the world's leading research
universities and the highest spending on research and development
of any nation. Thus I do not expect the long-run growth potential
of the U.S. economy to be materially affected by the financial
crisis and the recession if--and I stress if--our
country takes the necessary steps to secure that outcome.
Economic policymakers face a range of difficult decisions, and
every household and business must cope with the stresses and
uncertainties that our current situation presents. These are not
easy tasks. I have no doubt, however, that those challenges can
be met, and that the fundamental strengths of our economy will
ultimately reassert themselves. The Federal Reserve will
certainly do all that it can to help restore high rates of growth
and employment in a context of price stability.